Oil prices have seen a significant surge of 15% in the past month, thanks to production cuts made by Russia and Saudi Arabia. The reduced output has resulted in a global oil deficit, forcing refiners to tap into reserves to meet customer demand. Consequently, oil shortages have led to a spike in prices.
Curiously, while oil prices are soaring, oil stocks have not seen a similar increase. The SPDR S&P Oil & Gas Exploration & Production ETF (ticker: XOP) has remained relatively flat, with a decrease of less than 1% in the past month. This discrepancy may be due to the fact that stocks had previously outpaced oil prices earlier in the year and are now catching up. Additionally, concerns about the broader economy and future expectations for oil prices have dampened investor sentiment.
The futures market is predicting a drop-off in oil prices for next year, with Brent futures expiring in May trading at $88. This anticipation of lower prices may be shaping investor behavior as they remain skeptical about the sustainability of the recent rally in oil prices. There is also a lingering uncertainty regarding the overall health of the economy, which could further suppress stock performance.
In light of these factors, some experts believe that investors are choosing to sell energy stocks as a precautionary measure against a potential economic slowdown. Leo Mariani, an analyst from Roth MKM, underscores this sentiment, stating that “energy is usually sold into a potential economic slowdown.”
Despite the frustration felt by investors hoping for a boost in the oil industry, sentiment remains cautious as expectations for future developments in oil prices and the broader economy persist.
As the oil prices soar to new heights, some investors are noticing an intriguing disparity in the market. While the major U.S. oil companies are thriving, there are other companies with slightly lower valuations that seem to be lagging behind. Occidental Petroleum (OXY) and ConocoPhillips (COP), for example, belong to the second tier of U.S. oil stocks in terms of market value, and they are currently trading well below their previous levels when oil prices were at these peaks.
Bill Smead, the chief investment officer of Smead Capital Management, which holds shares in oil companies, points out that Occidental stock was valued at $73 during the last period of expensive oil in November 2022, while Conoco’s stock price reached $135. However, today, Occidental shares trade at $65, and Conoco is at $123.
Interestingly, institutional investors who still find oil stocks appealing have been gravitating towards the major players in the industry since the pandemic began. When oil prices plummeted in 2020, these major companies became the only viable options for institutions to invest in without causing significant market disruptions.
In a recent note, Smead highlighted why the cheaper oil and gas shares are trading at much lower prices compared to their counterparts, even when the oil prices are similar. According to him, these undervalued stocks remain relatively insignificant for large pools of money to consider.
However, Smead suggests that the larger oil companies may have an opportunity to capitalize on this disparity by acquiring the smaller ones. This consolidation within the industry could prove beneficial for both the major players and investors. In fact, Smead argues that now is the ideal time for investors to take advantage of the undervalued stocks in anticipation of this potential consolidation.
Smead further emphasizes that as the demand for fossil fuels shows no signs of diminishing and criticism against oil exploration continues, something is bound to change in the industry. This change could either manifest as a substantial increase in oil and gas drilling or, more likely, through the consolidation of the industry by the very large-cap companies. These companies, he believes, were hesitant to pursue such consolidation strategies in the past when prices were much lower. Ultimately, Smead sees an extraordinary opportunity for investors in these undervalued oil-and-gas companies.
In conclusion, investors are witnessing an intriguing imbalance in the oil stocks market. While major oil companies thrive, some slightly undervalued companies lag behind. Consolidation within the industry may offer an exciting opportunity for both the major players and investors alike. As the demand for fossil fuels persists, it remains to be seen how this disparity will unfold in the coming years.
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